Office vacancies up, rents down
In a sign that the economic slowdown is affecting Southern California businesses, the rents on office space are down slightly over last year, and vacancy rates are up.
In some parts of the region, office buildings that once housed mortgage lenders and other housing-related businesses stand 20% empty, according to brokerage Cushman & Wakefield. Even in desirable Santa Monica, vacancies have almost doubled as companies have shunned the coastal area’s still-pricey digs in favor of cheaper rents elsewhere in the region.
Experts say the decline in rents and the jump in vacancies portend trouble, even in those parts of the region -- such as L.A.'s Westside -- where the market is still relatively stable.
“Santa Monica and the surrounding area have been ground zero for digital media,” said David Toomey of real estate brokerage Cresa Partners. “But in the last year or two, the spike in rental rates and lack of product has caused a lot of sizable digital media companies to move out, and look outside the Westside.”
Fox Interactive Media, the home of MySpace, announced this year that it was moving to a 300,000-square-foot headquarters in Playa del Rey. PriceGrabber.com Inc. is moving from Westwood to Fox Hills. And a handful of other smaller start-ups are unable to be in Santa Monica at all, Toomey said. They’re going instead to Marina del Rey, Venice, Culver City or places farther afield.
The amount of rented office space in Los Angeles County has fallen by 1.3 million square feet this year.
That’s a small fraction of the roughly 189 million square feet available in the county, but last year at this time the county had a net gain of more than 2 million square feet.
Altogether, Los Angeles County had a vacancy rate of 11.6% including sublease space at the end of the third quarter, up slightly from 9.5% a year ago.
“We are certainly going to see vacancy rates go up as we go into this economy,” said Joe Vargas, regional manager of Cushman & Wakefield. “Rental rates will be slow to adjust down, but we are going to see it happen.”
The situation is worse in Orange County, where office vacancy rates rose to 16.2% in the third quarter from 11% a year ago, spurred in large part by the closing of several lenders that specialized in subprime mortgage loans. In the buildings around John Wayne Airport, however, vacancy has surpassed 20%.
Although the drop in rents and the increase in vacancies remain slight or moderate in parts of the region, experts say the economic slowdown is likely to mean difficulties ahead. Trouble in the economy takes months or even years to show up in vacancy rates, because businesses sign long-term commitments when they rent offices.
“When companies downsize, they don’t immediately give up their space,” said Richard Green, director of the USC Lusk Center for Real Estate.
Green predicted that landlords would keep their asking rents up as long as they could while offering other incentives such as reduced parking prices and generous allowances to help tenants build out their office interiors. It’s only when those types of inducements are no longer sufficient that property owners tend to lower rents, he said.
In Los Angeles County, landlords are still keeping office rents up -- and in many cases still getting what they want. Average asking rents were up 12 cents a square foot from last year at this time to $2.81 a square foot per month. But that doesn’t mean businesses will continue to pay those rates.
As vacancies go up, rents typically go down, and brokers say rents have already started to fall in several markets.
In Santa Monica, however, where landlords continue to ask $4.95 a square foot despite the increase in vacancy rates, the rents are proving high enough to scare off some of the young tech companies that have flocked to the Westside since the dot-com boom began a decade ago.
On one hand, said Benjamin Kuo of the website SoCalTech.com, tech companies like to be close to one another. It makes it easier to recruit employees and attract investors. It also allows employees to network and socialize with other techies.
“You have to provide the right work environment, and part of that is location,” said Toomey of Cresa Partners.
But for some tech companies, being in a nice, affordable space is more important than cramming into Santa Monica, no matter how fun the parties are. Ron LaPierce, president of PriceGrabber.com, moved the company from Westwood to the Wateridge facility at La Cienega and Slauson last month -- after his landlord had sought to triple the rent.
“It was a slam-dunk decision,” he said.
Eventually such moves will push vacancy rates even higher and force rents back down. That trend will affect the economy as building owners take in less and the businesses that service office workers find that they have fewer customers.
“We have really been suffering from lousy demand for more than a year, yet rents continued to go up” because landlords didn’t have much vacancy, said broker Hunt Barnett of Madison Partners.
Landlords in downtown Los Angeles, the region’s second-largest market, don’t want to give up recent rent gains either, despite the slowdown. “There’s not much pressure to drive rents down,” said Bert Dezzutti of Brookfield Properties Corp., which owns three big high-rises downtown.
All but one of Brookfield’s seven buildings in Los Angeles County is close to fully leased, according to research firm CoStar. The landlord hasn’t yet felt the need to lower rents and doesn’t intend to.
“We understand that real estate is cyclical,” Dezzutti said. “We think it’s only going to get better.”
Landlords in Orange County and the Inland Empire are facing a double whammy of increased vacancies at the same time that more than 2 million square feet of new office space was finished.
“You can see why vacancy is going up fast,” said broker Kurt Strasmann, who oversees Orange County and the Inland Empire for Grubb & Ellis.
That trend will continue in Orange County through next year, Strasmann predicted, but could reverse in 2010.
The picture is grimmer for landlords in the Inland Empire, where vacancies doubled over the last year to 23% but average asking rents came down only 6 cents a square foot.
The office market in San Bernardino and Riverside counties has been badly damaged by the housing bust, Strasmann said. “The flow of deals to the Inland Empire has stopped because of the financial crisis.”